Eurozone Factory Prices Slip, Fueling ECB Rate-Cut Calls

Eurozone factory prices fell more than expected in May as the cost of energy dropped sharply, reinforcing the case for an ECB interest rate cut as early as this week to aid the region's stagnant economy.

Prices at factory gates in the 17 countries using the euro slid 0.5 percent from April, the European Union's statistics office Eurostat said on Tuesday, as Brent crude continued to fall and change the inflation outlook.

The International Monetary Fund says now is the time for the European Central Bank to cut interest rates to help the eurozone, where many economies are in recession, although with rates already at a record low 1 percent, any impact may be limited.

"The ECB has one small bullet left and it will fire it on Thursday, but then after that it is basically out of ammo," said Nick Kounis, head of macroeconomic research at ABN AMRO, who expects to see a 25 basis point cut in the refinancing rate.

A Reuters poll showed that 48 out of 71 economists expect the ECB to cut rates on Thursday, in theory making it cheaper for the eurozone's hard-pressed households and firms to borrow.

After months of stubborn consumer and industrial inflation, price pressures have abruptly eased, mainly because crude oil that traded at more than $120 a barrel earlier this year is now below $100, pushed down by the weakening global economy.

That was evident in the producer price inflation data, which on an annual basis rose at a slower rate than expected, climbing 2.3 percent in May versus forecasts of a 2.5 percent increase.

On a monthly basis, economists in a Reuters poll had forecast a shallower, 0.3 percent, fall than the final reading.

Within the index, energy prices for factories in the eurozone tumbled 1.4 percent in May from April, after rising as much as 2.6 percent at the start of the year.

IMF CALL

Concerns among businesses and investors that the eurozone's 2-1/2 year-long debt crisis is no closer to any lasting resolution has started to eat away at the resilience of the U.S. and Chinese economies, stifling global growth and hitting oil.

With commodity prices lower and the eurozone's economy expected to have contracted in the April-to-June period, consumer inflation has also fallen, to 2.4 percent in June.

"With inflation pressures expected to weaken substantially, the ECB has room, albeit limited, to ease policy rates and signal a commitment to a more accommodative stance for a prolonged period," the IMF said in a report last month.

The ECB left rates at 1 percent last month and ECB President Mario Draghi argued it was up to governments, not the bank, to take steps to help calm the crisis that has intensified as Spain and Cyprus became the latest countries to seek a rescue.

But after eurozone leaders agreed in the early hours of Friday to take action to try to bring down Italy and Spain's borrowing costs, a pact for growth and jobs and to create a single supervisory body for eurozone banks, the onus may again be on the ECB.

"Although Mario Draghi rejected the idea that there could be a quid pro quo between monetary policy and fiscal discipline, it seems likely to us that the Governing Council wanted to see the outcome of the EU summit before showing its cards," said Olivier Bizimana, an economist at Morgan Stanley.

"At this stage, the consensus amongst ECB watchers ... seems to be shifting towards a cut," he said.

Some economists also foresee a reduction in the ECB's deposit rate — the rate it pays commercial banks for overnight deposits at the ECB — to zero from 0.25 percent on Thursday.

If the ECB cuts the deposit rate to zero, banks would be more likely to lend money overnight to other banks for a higher market rate than park it for zero return at the ECB.

"That would actually have some impact in terms of easing," ABN AMRO's Kounis said.